RBA Observer: On hold next week, next move likely to be up

• Activity indicators are lifting and this
month brought more news that the labour market is also
improving• Inflation has already passed its trough,
the housing market continues to boom and the cash rate is
still at its historic low• It seems likely that the
RBA will soon need to consider that rates should start to
head towards neutral: we expect that the cash rate may need
to rise before year-end

Growth and inflation are
picking upLocal activity indicators are continuing
to show that growth in Australia is rebalancing from being
led by mining investment, as it has been in recent years, to
being driven by the non-mining sectors of the economy. GDP
picked up pace in Q4, supported by consumption and exports.
In addition, retail sales are growing at their fastest rate
since 2010, the housing market continues to boom, the
forward-indicators of residential construction have picked
up strongly and the business sentiment is at significantly
higher levels than it was around the middle of 2013.
Inflation has also lifted and appears to have passed its
trough, which is another sign that demand has been picking
up.

These facts alone might suggest that the current very
low cash rate may not be the appropriate monetary policy
setting and that rates should be lifted soon. But two key
caveats remain: the labour market remains weak, with the
unemployment rate at its highest level in 10.5 years; and,
mining investment is set to fall further this year and
next.

On both these factors we are more sanguine than many
other commentators. We see the labour market as merely
lagging the pick-up in activity that has already begun. We
have long been arguing that as the economy shifts to being
more driven by the non-mining sectors, employment growth
should lift. After all, that is where most of the jobs are!
The mining sector employs only a small number of people.
This month brought support for our view with strong
employment numbers in February.

With regard to the
expected fall in mining investment, we forecast that it will
be more than offset by a pick-up in resources exports, as
new capacity comes on-line, and falling imports (recall that
much of the capital for the mining investment was
imported).

The past month has seen the market focus shift
to the local data, consistent with our view that inflation
and jobs are the keys for determining the RBA's next move.
We expect the RBA to be on hold for the next few months, but
for rates to rise before year-end.

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